[Prior research has found that loan loss provisions are positively associated with bank stock returns and future cash flows, conditional on less discretionary information about loan default. We find that these positive valuation implications obtain only for loan loss provisions for low regulatory capital banks in the fourth fiscal quarter. Our regulatory capital-based tests are motivated by the idea that increased discretionary loan loss provisions are plausibly good news only for banks which appear to have loan default risk problems based on prior information. Our fiscal quarter tests are motivated by findings in prior literature that suggest that managers have incentives to delay income decreasing accruals until the fourth quarter when the audit occurs, implying that income decreasing accruals are more likely, and therefore more expected, in the fourth quarter than in other fiscal quarters (Mendenhall and Nichols 1988; Boyd et al. 1994).]

Banking, Disclosures, Bank loan portfolio compositions, Market reaction

Prior research shows that during the pre-1990 bust financially weak banks managed income upward by delaying provisions for losses on heterogeneous loans. In contrast, we predict and find that during the 1990s boom profitable banks managed income downward by accelerating provisions for losses on homogeneous loans. Profitable banks obscured their income smoothing by accelerating charge-offs of homogeneous loans and by recording more gross charge-offs to offset recoveries of previously charged-off loans. Over the three years subsequent to the acceleration of charge-offs, they had higher and more persistent income before provisions for loan losses than other banks, consistent with income smoothing over a prolonged horizon.

The upsurge of shadow banking is typically driven by rising financing demand from certain real sectors. In China, the 4 trillion yuan stimulus package in 2009 was behind the rapid growth of shadow banking after 2012, expediting the development of Chinese corporate bond markets in the poststimulus period. Chinese local governments financed the stimulus through bank loans in 2009 and then resorted to nonbank debt financing after 2012 when faced with rollover pressure from bank debt coming due. Cross-sectionally, using a political-economy-based instrument, we show that provinces with greater bank loan growth in 2009 experienced more municipal corporate bond issuance during 2012–2015, together with more shadow banking activities including trustloans and wealth management products. China’s poststimulus experience exhibits similarities to financial market development during the US National Banking Era.

We hypothesize and provide evidence that characteristics of banks’ loan securitizations accounted for as sales determine the extent to which banks retain the risks of the securitized loans. We show that banks retain more risk when: (1) the types of loans have higher and/or less externally verifiable credit risk, (2) the loans are closed-ended and banks retain larger contractual interests in the loans, and (3) the loans are closed-ended and banks retain types of contractual interests that more strongly concentrate the risk of the securitized loans. We show that the magnitude and type of retained contractual interests are not risk-relevant in revolving loan securitizations, because banks have more incentive and ability to provide implicit recourse, a non-contractual interest.

Recent reform in China has made a subset of Chinese stocks available to foreign investors, partially opening up China's stock market. Our difference-in-differences analysis shows that this liberalization reform boosts investments in investable firms relative to noninvestable ones, with results robust to various sensitivity analyses. Besides capital inflows and risk sharing, a potential but underexplored channel is improved corporate governance due to direct and indirect pressures from foreign investors, which lowers the cost of capital and improves capital allocation efficiency. Consistent with this corporate governance channel, we find that the liberalization reform reduces investable firms’ agency costs, increases their investment efficiency and total factor productivity, and improves their operating performance. Further analysis finds that the positive investment effect from the liberalization reform is stronger among firms that were poorly governed before the reform.

Prior research has found that loan loss provisions are positively associated with bank stock returns and future cash flows, conditional on less discretionary information about loan default. We find that these positive valuation implications obtain only for loan loss provisions for low regulatory capital banks in the fourth fiscal quarter. Our regulatory capital-based tests are motivated by the idea that increased discretionary loan loss provisions are plausibly good news only for banks which appear to have loan default risk problems based on prior information. Our fiscal quarter tests are motivated by findings in prior literature that suggest that managers have incentives to delay income decreasing accruals until the fourth quarter when the audit occurs, implying that income decreasing accruals are more likely, and therefore more expected, in the fourth quarter than in other fiscal quarters (Mendenhall and Nichols 1988; Boyd et al. 1994).

We document that firms in more politically corrupt regions of China adopt more conservative accounting. The relation between local political corruption and accounting conservatism weakens after China’s anticorruption campaign launched in 2012 and in firms with a lower risk of expropriation by corrupt officials, stronger incentives to report earnings aggressively, or greater gains from corruption. Further analysis shows that accounting conservatism and alternative corporate strategies complement each other in shielding firms against corrupt officials’ expropriation of corporate resources. Our study provides novel evidence about an accounting approach used by firms in response to perceived political costs.